Category Archives: Shariah Compliance

Following my earlier writing on the Digital Wallet / ePayments and how such transactions may have not breached Shariah requirements but lacks the validation to ensure all elements do not touch the prohibited elements, I am called to further expand on the topic. In my opinion, there are possibilities that more Shariah-Neutral products and transaction enter into the space of Islamic Banking, but without the validation of Shariah scholars or committees and yet, it will remain acceptable. It is possible, and it is already happening now.

“NO PORK NO LARD”

It is an interesting situation in Malaysia now, when it comes to food. In general, Malaysia as a Muslim country, the expectation is that the food consumed must be Halal and more importantly certified as such. The reason for it is that it gives comfort to the public that certain standards are adhered to according to religious requirements. To walk into a restaurant with the Halal signage gives us Muslims confidence to consume the food till our bellies are filled.

But there are challenges. The desire to ensure the standards are met has resulted in difficulties for restaurants getting certification quickly. The process is detailed and granular, and this is a good thing, but can be disheartening when the certification drags. And in some cases it is impossible to obtain, especially if the eatery has halal standard food but also offers alcoholic drinks to its non-Muslim customers. The Muslims know (or assume) the food is halal if they see there is no pork on the menu, and will ignore the alcoholic drink. This is now a common sight in Malaysia.

And thus the loop-hole or short-cut is discovered. Rather than going for certification of Halal for their restaurant, many owners now deemed it sufficient that the signage “No Pork / No Lard” will result in a Halal understanding. And this may be true; many small roadside businesses do not carry a Halal certification but is nonetheless patronised by Muslims as it does not carry pork on the menu. That cue is taken by the restaurant owners and over a period of time, the “No Pork / No Lard” now is understood to be serving halal food but without Halal certification.

DOES “NO PORK / NO LARD” MEANS IT’S SHARIAH NEUTRAL?

Taking that concept into the banking world, will consumers eventually be accepting Shariah Neutral products and services as the new norm? A product or services with no prohibitive elements that is deemed acceptable by both the producer and consumers but without any Shariah Committee validation. For many years some conventional banks have been offering Shariah compliant third party Takaful or Unit Trust products which was vetted by the Shariah Committee of the providers.There is total reliance on the providers validation for Shariah compliance.

Additionally, there are products and services that is by nature, very close to meeting the Shariah requirements in a contract. For example the leasing products which is perhaps 95% in line with Shariah requirements for Ijarah such as rental arrangements, ownership transfers and roles and responsibilities of lessor / lessee. The contention will always be the penalties and perhaps some operational practices, but in my view, these can be amended.

THEY WALK AMONG US

Believe it or not, there are already efforts on becoming Shariah-neutral where it is deemed acceptable practice for attracting Muslim consumers. Some non-Islamic banks have been aligning some of their products features to be consistent with Islamic banking practices under the guise of responsible financing or sustainable banking. For example, the compounding late payment interest which some non-Islamic banks no longer practice. Another example is that some are considering to remove “Commitment Fees” from unutilised financing balances in overdraft / revolving credit to align it to Islamic banking practices. We are starting to see non-Islamic banks realigning themselves to be on par with Islamic banking practices. Just to regain the competitive edge.

This will eventually lead to offerings that remove the prohibited elements and validated as acceptable by the public themselves, without further validation of Shariah scholars. Can a non-Islamic bank eventually offer products that it deemed as meeting the Shariah expectations? Surely, Shariah Committee will not have jurisdiction over a non-Islamic bank offering Shariah-Neutral offerings.

The more crucial question is perhaps : Will the public eventually become not so demanding for a stricter (or complicated) Shariah Compliant product, and begin accepting Shariah-Neutral products that is offered by non-Islamic banks? Is that possible?

Such offerings may be offered via the digital world where the contractual lines are not so clear. Rebranding of a product can be done with minimal effort. The terms used can be made Shariah-friendly. How a transaction is handled behind the scenes may be less important with the convenience of using Apps or Mobile Banking. And without Shariah scholars prohibition or decision on such matters, the public will hold to the opinion that it is deemed compliant and thus acceptable. Eventually, this opinion will become customary and generally accepted.

“No Pork No Lard” may one day become the new acceptable norm in the non-Islamic banking space. And my suspicion, a lot of sceptics of Islamic Banking already hold this view. Maybe it is time to make clear of the colours of the offering; is it white or is it black? Otherwise, the colour of grey will become the new white.

I came across an interesting article titled Hidden Traps in Shariah Decision Making by bro Ehsanullah Agha (click on picture for full pdf article). The article summarises what we product developers have known for quite some time now, and has now become necessary tools in ensuring the products we design are approved by our Shariah Committee. It summarises the involvement of Shariah in decision-making in an IFI, as well as some of the “traps” that Shariah Committee falls into when making decisions.

The 4 “traps” mentioned are:

Anchoring an opinion

Adhering to the Status Quo

Confirming Evidence to support a decision

Framing of information

While the above is referred to as “traps”, I would rather refer these as “approaches” to solicit a decision, and perhaps all the above can come together (not exclusively) in considering a decision. Reading the above exclusively may give the impression that a product team can resort to a specific tactic in order to extract a certain decision. Admittedly, there are such cases, especially where management requires a specific decision to support a business. But Shariah Committees are often expected to be the gatekeepers for such decisioning.

A quick comment on the above points:

Anchoring. While product teams do not consciously try to anchor an opinion before presenting to Shariah Committee, we often do so to provide perspective on the rationale for such proposal. This can be done by highlighting a crisis or regulatory danger to support the proposal. It becomes the baseline discussion point during the deliberation stage. And we do it to keep the discussion in focus to achieve the objective ie resolving the crisis.

Status Quo. By far this is one of the main consideration of an approval by Shariah Committees. Usually we call it Urf ie customs or acceptable market practice on a certain product behaviour. Personally, decisions based on Urf is not something I prefer but it is sometimes necessary to quote as such, especially if there is no major criticism on its usage and practice by the public (which also includes religious scholars). There is nothing wrong with accepting the norms of the society; my only contention is that I may not fully understand the deliberation points when such decisions are made by other parties for the fear of missing out a critical argument that should have been known and resolved by my team. Two things come to mind; Ignorance is bliss, and Blind leading the blind.

Confirming Evidence. This is also a key point where a certain decision is preferred over the other. When there is a bias for arriving at a certain decision, the product research, analysis and design (including practicality in operations) are equally biased in finding evidence to support reaching of that decision. Rightly so as mentioned in the article, the evidence to support the contract of Bai Inah in Malaysia is generally extracted from the Shafie school of thought while sidelining the rest of the opinion that is equally valid. The evidence provided for the acceptability is biased to enable the consideration to approve the structure.

Framing. In my opinion, framing is a necessary tool for product development teams simply due to the amount of information available in the market. While we understand the need for a robust deliberation session with the Shariah Committee, the forums available to us (and the allocated time given) are usually restrictive. To go into full academic and technical discourse will be challenging especially when a quick decision is required. The information that we provide are those we deemed most relevant to support the proposed solution. There may be other decisions that the Shariah Committee can arrive at, if only we had provided more information. But the danger lies where the inclusion of too much information may result in indecisiveness or confusion. Sometimes too much information clouds the real issue further, and it takes time to bring things back into focus. Therefore, we frame the information relevant to the issues. The intention is not to exclude, but to include what is relevant.

A GOOD DECISION COMES WHEN ALL PARTIES ARE ENGAGED

When a product team goes into a proposal, discussion or request for a certain decision, the Shariah Committee is expected to be conversant with the topic at hand to be able to engage in a meaningful discussion. The product team brings in the technical requirements, with some general Shariah background information, market analytics and practical implication on process requirements expected by Shariah. The Shariah Committee must bring in their expertise in Shariah knowledge to dissect and analyse the team’s proposal, not just what is being presented as information but also the rationale, the intention and the technical nuances proposed for the product.

Asking the right question is important for the Shariah Committee, just as providing the right context and intention is also important for the product team. In general, the product team must not go into a Shariah proposition with the intention to manipulate, coerce or blindside the Shariah Committee into a “business” decision. The effort must show full consideration in compliance with Shariah. As much as the heavy burden placed on the Shariah Committee shoulders are real (with fines and jail-time outlined under IFSA2013 when there’s failure to execute their duties), the same burden must also be felt by the IFI’s product team whenever a product is being designed and launched. The people I work with, I see strong commitment and awareness on the need to do the right things, all the time.

WISH LIST FOR 2019

It is easy to expect Shariah Committee to be well versed in all aspects of banking and finance when the decision is required. And it is also easy to expect product development teams to be fully aware of all “relevant” information to be able to share them objectively with the Shariah Committee. Such an ideal scenario will mean all parties come to the table fully aware of all the potential issues, with sufficiently extensive information and in-depth theoretical research to support all the argument. This does not always happen in real life.

I believe the only way to bridge this expectation is to significantly increase the knowledge of all parties. We see this starting to happen at the Shariah Committee level where BNM now encourage at least 1 industry expert to sit in the Shariah Committee, even without a Shariah background. This is to promote knowledge sharing and a different point of view during decisioning, and take notice of any attempts to coerce a decision.

On this same vein, I believe the next natural step is to have Shariah-trained individuals to become product developers in IFI. Most Shariah-based graduates that we see, enter into the banking world via the Shariah department. But how about entering other departments such as sales, credit or more importantly product-development? Such background knowledge in Shariah may itself force a self-regulating approach when designing a products. The Shariah arguments will be the first filter when assessing a product; if it fails at that filter, it will not see the light of day. And Shariah Committee can take some comfort that the Shariah deliberation has already started at the onset of the product development process.

I have seen some impressively good work done by Shariah-based product developers. This should be the way forward in finding new Shariah-compliant banking solutions. Hope I get this wish next year. Looking forward to 2019.

Islamic Banking in Malaysia is fast reaching a crossroad. While Islamic Banking continues to offer like-to-like conventional structures, the requirements by Shariah Committees and Policy Documents by Bank Negara Malaysia continues to challenge the way Islamic Banks implement and operationalise the products within a viable banking structure. Islamic Banks are becoming mindful of the need to comply fully to each policy requirements.

It is precisely this fear of being “non-compliant” to these requirements that pushes many Islamic Banks to develop the Tawarruq-based products into its most efficient form. As I have written earlier in Disruption : Islamic Contracts where I felt the Tawarruq arrangements has become the “go to” structure that Islamic Banks can easily comply with, the notion that other contracts such as Musyarakah or Ijarah or Mudharabah may now be left behind in its development due to perceived complexities. Or in some cases, difficulty to comply due to the existing banking set-up, especially in matters of risks, capital and operational processes which is intrinsically based on conventional banking infrastructure.

BUT CAN TAWARRUQ ALWAYS BE THE ANSWER?

It is generally accepted that a lot of processes in the Tawarruq arrangement can be complied with. There were strong operational support and infrastructure both internal and external, such as the London Metal Exchange (LME) and Bursa Suq Al Sila which has an efficient commodity platform specifically designed to support Tawarruq with or without commodity brokers, to the choice structure that bridges the middle-east players to most of the rest of the Islamic Banking geographies. But that is by no means that Tawarruq is a perfect solution for Banks.

Despite Tawarruq is now greatly used over the last decade or so, there are still contention points that remains amongst financial practitioners and Shariah scholars. Most scholars want to have the view that Tawarruq should be the “contract of last-resort” but what we see now are quite the opposite. It is the preferred choice being used not just for Working Capital requirements, but now also for Asset Financing, Mortgages, Trade Financing, Fixed Deposits, Structured Investments, and even Savings Account. Whenever an Islamic Bank hits a roadblock with a particular product being developed or requiring compliance to the latest rules, the tendency is always to consider Tawarruq as the solution.

If this is the approach, how much do we really need other Islamic contracts which only addresses a single problem or requirement? Shouldn’t we develop Tawarruq as far as it can take us and make other contracts as “supporting” contract to cater for specific nuances?

THE UNANSWERED QUESTIONS ON TAWARRUQ

Each year when Bank Negara Malaysia audit comes around, there will always be new compliance points to be proven and tested. Even at the level of understanding and interpreting the Policy Documents into processes and banking operations. Each Bank interprets the rules differently, and each banking set-up have different operational capabilities which more often than not, requires exceptional Shariah indulgence. So, the questions will remain unanswered whenever dispensation is obtained.

Many argue that the main issue of Tawarruq is actually the “intention” of the contract itself, and that intention is not to “trade in commodities” but to create debt via a trading transaction. This has been debated at length for many years in all types of forum, but we concede on some of the arguments by virtue of there being no other viable solution to cater for certain banking requirements. Islamic Banks, and its scholars, had to choose either:

Allowing for the Tawarruq arrangement with strict adherence to requirements until a solution arrives, or

Disallowing the Tawarruq arrangement which may result in customers being impaired in their Islamic business, which may result in the customer reverting to a conventional banking solution.

Is there a case of choosing the lesser of two evils?

Nonetheless, I won’t discourse what have been extensively discussed, but instead look at the operational issues of Tawarruq arrangements that I pick up going through the Tawarruq Policy Document. Among them that are still being debated in different forums are:

The issue of Commodity Delivery – To demonstrate that the Tawarruq being practised by the Bank is real, the test of delivery of Commodity is a key qualifying factor. The Bank must have in place a mechanism that allows the customer an option to take delivery of the commodity whenever the customer calls for it, bearing in mind that may have not been the intention in the first place i.e. taking delivery of commodities. How a Bank prove this to Shariah Committee and regulators are crucial to demonstrate “real transaction” and paper transactions.

The issue of Price Fluctuation – Depending on commodities, its price tend to fluctuate periodically, because these are actual live commodities being traded. Because of this, Banks have not been able to be precise in its documentation or price disclosures. Whatever price per commodity unit at 10am, it might change at 2pm, so how do you lock-in a specific price when the buy and sell of the commodity was not concluded immediately? The fact that Bursa Suq Al Sila states in its guidance notes that an Islamic Bank could not hold the commodities for more than 2 hours implies the issue of price fluctuation is a valid concern for Shariah Committees.

The issue of Discrepancies of Terms – Because the Murabahah transaction in the Tawarruq arrangement is the most crucial contract, Scholars always insist on the details of the transaction to be as precise as possible to ensure what was offered was eventually rightly accepted. For example in a Personal Financing structure, the customer makes a credit application according to certain terms such as financing amount, or financing tenure, but what eventually gets approved might be a lesser amount or shorter tenure, which means differences in the initial “Agency” instruction to transact the commodity. Scholars question how do Banks re-engage customers with such “counter-offer” for their acceptance? At which point after the credit approval?

The issue of Delay in Transactions – Some banks are more efficient than others. Some banks are able to conduct commodity trading on the same day while others can only do it in the next day after the day’s batch run. End of day batch runs are what conventional banking live by, and there is no motivation to conclude and consolidate all transaction in real-time; there is no requirements to do so. Batch runs allows for more systematic consolidation of records. But that becomes an issue for Islamic banks running next to a conventional banking proposition. So if an Islamic bank is limited to only end of day batch run to consolidate its records, it means the end of week transactions requirements will only be fulfilled on the next working day (across the weekend). This is a delay in the conclusion of the initial instruction given by customer to conduct Murabahah which may impact specific terms including price of commodity and its availability. There is also the danger of missing out delayed transactions as those instructions are not “current” anymore. There is a provision in the Policy Documents that “delay” in transaction should not be more than 2 days (T+2), but there are also periods where the off-days are more than that due to public holidays and other disruptions.

The issue of Qard in Tawarruq – An extension of the above scenario where Commodity transactions are delayed, the next question will be “what is the status of the funds when no transaction is done?” Is it a Qard (Loan) contract until the transaction is fulfilled, or is it an Amanah (Trust) arrangement? In either case, for the scenario of Tawarruq Deposits, how do you accrue the profit for both contracts which forbids “interest” or “returns“? Profit is only realised once the Murabahah (trade) takes place. Without the trade being transacted, profit accruals can only be justified by arguing that Islamic banks should not penalise customers who, in this case, has done nothing wrong. Dispensation is always given for the reason of fairness. And this “Incidental Qard” issue has also been discussed at the Shariah Advisory Council of Bank Negara Malaysia, where the fatwa on Incidental Qard and its conditions were issued. But the fact that it was discussed, indicated that this issue is not as easily brushed aside as one like to think.

The issue of Agency and Dual Agency – There are still some banks that feels the Dual Agency structure contributes greatly to the notion of “arranged” Tawarruq and thus stays away from it. The Dual Agency structure is where the customer appoints the Bank as both the Buying Agent and Selling Agent. This gives the Bank the full right to conduct trading without any Customer intervention (given mandate), which makes the “ability or option to take delivery of commodity” redundant or unnecessary requirement. It effectively removes the proof of Murabahah i.e. deliverability of the Commodity.

The issue of Physical Commodity – One of the main contention is the ability to ascertain the availability of Commodity. While on paper it can be evidenced but nonetheless the challenge is to ensure the Commodity is identifiable and deliverable according to quantity. Efforts have been made to split into smaller denominations whenever needed, and commodities like Crude Palm Oil (CPO) is easier to be allocated. But there is always suspicion whether this is superficial where proof of otherwise is actually much more difficult to obtain. Where is the certainty that the assets being traded are the right physical ones?

THE REAL QUESTION IS WHETHER THE ABOVE CAN REALLY BE RESOLVED

So is there any other alternatives to Tawarruq? The above questions have so far not been answered satisfactorily and scholars while do not prohibit its usage, still frown on how much Tawarruq has impacted everyday banking life. It is truly a “love/hate relationship,

I believe there is such “replacement” contract that can address most, if not all, of the above concerns. But it needed to be proofed and challenged and at the end of the day, we question such necessity and thus the rising dilemma to replace it after all the work done. Tawarruq has really taken root with so much invested in perfecting the structure, and expertise in its documents and mechanism. It solves a lot of problems, yes. But will Tawarruq be the end of innovation for Islamic Banking?

I like to think there must life beyond Tawarruq. It just needed courage to acknowledge the big task required for such massive structural changes in replacing Tawarruq. Such replacement must not just be an equal substitute but also addresses the Shariah concerns. That is the ultimate test of any Islamic Banking contract; the reason for being.